The next phase of the bank bailout plan presented by Treasury Secretary Tim Geithner (now slated for Tuesday) is expected to be multi-faceted but missing one key element: An admission by policymakers that major U.S. banks are insolvent.
There are two explanations why the Obama administration (like its predecessor) refuses to even acknowledge this possibility in public, says Martin Wolf, chief economics commentator for The Financial Times:
- One, policymakers have better information than private economists and really believe the big banks aren’t insolvent, i.e. they continue to view the crisis as a “liquidity problem,” and believe so-called toxic assets will return from their currently “artificially low” levels once confidence is restored.
- Two, policymakers “are not prepared to admit the truth” because it means existing shareholders and bank managements will be wiped out. It also means “admitting total failure” of efforts to date to stem the crisis, says the author of Fixing Global Finance.
Arguing today’s toxic assets are “fundamentally worthless” – and there’s lots more losses coming – Wolf says the lack of political will (or outright cowardice) to admit to reality means “we’re really in trouble.” Why? Because confidence in policymakers will continue to deteriorate as their ill-conceived solutions continue to fail.
Once policymakers (ultimately) agree insolvency is really the underlying problem, there are two options for dealing with the banks:
- Nationalize them, and then inject government capital as the U.K. government has started to do with RBS and Lloyds. (a.k.a. The Swedish Solution)
- Put them into FDIC receivership or force them into bankruptcy, whereby common stock and preferred debt shareholders get wiped out and “senior” debt holders end up owning the banks.
Editor’s note: Stay tuned for part 2 of this discussion and check out these other segments with Wolf: